1031 Exchange Strategies – Two Important Ones

There are at least four different 1031 Exchange Strategies that can be used under different conditions to obtain the benefit of capital gains tax deferment. Two of them are described below.

1031 Delayed Exchange Strategy: This is the commonest strategy. It involves the sale of an investment property and then the time deferred purchase of another investment property within 180 days of the sale.

Under this strategy, three basic steps are to be followed in sequence. They are described below.

As the first step, an Exchanger enters into an Exchange Agreement with a Qualified Intermediary and arranges for the sale of his/her investment property (relinquished property) through the Intermediary.

As the second step, the Intermediary sells the relinquished property and retains the complete sale proceeds with him/her. The intermediary instructs the sale closing officer to transfer the title of the relinquished property to the buyer. The Exchanger identifies a potential like kind replacement property within 45 days of the date of sale of the relinquished property.

As the third step, the Exchanger has 180 days from the date of sale of the relinquished property or the due date of the tax return, which ever is earlier to complete the purchase of the replacement property. Before the purchase of the replacement property, the Exchanger will forward a Purchase and Sale agreement to the Intermediary. Once the replacement property has been finally identified by the Exchanger, the Intermediary will purchase the replacement property using the proceeds available from the sale of the relinquished property. The Intermediary will then transfer the direct deed of the replacement property from the seller to the Exchanger.

1031 Reverse Exchange Strategy: This is the opposite of the delayed exchange strategy. In this strategy, the replacement property is purchased before the sale of the relinquished property. This strategy is used in case the replacement property is available for a very short period of time. In this reverse exchange, the Intermediary’s role will be even more important given the lack of time for purchase of the replacement property.

For the successful implementation of the reverse exchange strategy, the Intermediary needs to purchase the replacement property from a seller and hold it till the Exchanger finds a buyer for the relinquished property. Once the buyer has been found, the Intermediary will transfer the deed of the replacement property to the Exchanger.

The Intermediary will then sell the relinquished property to its buyer, thereby completing the exchange. The funds required by the Intermediary for the purchase of the replacement property will be provided by the Exchanger. Normally it will be the responsibility of the Exchanger to manage the replacement property for the duration in which the Intermediary holds it.

Different 1031 Exchange Strategies suit different conditions. Besides the two above strategies, another two are 1031 Simultaneous Exchange and 1031 Construction/Improvement Exchange Strategies.

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